As the calendar turns over each year, investors look forward to a popular trading phenomenon on Wall Street known as the "January Effect."
It occurs when small-capstocks see a boost as investors buy back shares they sold in December. But Steven DeSanctis, Bank of America Small-Caps Strategist, says it's unlikely to happen in 2012.
"Valuations aren't really that attractive for smaller stocks," he said, noting that there are better fundamentals in mid-cap and large-cap stocks. With market volatility as high as it has been recently, DeSanctis added, it makes a little more sense to stick with larger-cap stocks.
Mid-to-large sized companies are a safer bet, as larger trading volumes mitigate volatility. Futher supporting his argument, the index representing small cap stocks — the S&P 600 — is currently underperforming its larger counterpart, the S&P 500 index.
"When you do get a January Effect, some of the stocks that have been beaten badly the year before tend to come back, and they're the ones that get the sharp rebound," says DeSanctis. "At this point, I don't see good valuations, or good fundamentals for this rebound to actually take place."
Retail investors typically sell their losing stocks in December for tax reasons. These losses offset their capital gains income for the year, which is taxed at a higher rate. Institutional investors also have an incentive to sell poor performing small caps at year-end, because it eliminates poorer performing names from their portfolios before first-quarter reporting pressure kicks in.
But what goes down does not necessarily come up, DeSantis says, noting that less-than-attractive fundamentals will keep small-cap stocks from popping in January.
"It's very hard to make the case that small will do better than large cap stocks next year," he says.
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DeSanctis does not personally own small cap stocks.